Analyzing Oil Price Shocks and Exchange Rates Movements in Korea using Markov Regime-Switching Models

Abstract

Korea imports all of its crude oil, and is the world's fifth largest oil importing country. We analyze the effects of oil prices, interest rates, consumer price indexes (CPIs), and industrial production indexes (IPIs) on the regime shift behavior of the Korean exchange rates against the USA from January 1991 to March 2019. We use the Markov regime switching model (MRSM) to detect the regime shift behavior of the movements of Korean exchange rates. In order to select the optimal MRSM, we fit a total of 30 models considering four explanatory variables. The selected model based on Akaike information criteria (AIC) and maximum log likelihood (MLL) includes the log-differentials of oil prices, the log-differentials of CPIs compared to those of the US, and its own auto-regressive terms. Based on the selected MRSM model, throughout all markets, we find evidence to support the existence of two distinct regimes: a stable regime with low-volatility, and an unstable regime with high-volatility. The regime with high-volatility includes the Asian financial crisis of 1997 and the global financial crisis of 2008-2009 in the Korean exchange rates market. In the regime with low-volatility, the Korean exchange rates are not significantly influenced by any of the explanatory variables, except for its own auto-regressive terms. In the regime with high-volatility, the Korean exchange rates are significantly influenced by the CPIs and oil prices. The transition probability from the regime with low-volatility to the regime with high-volatility is about ten times that of the opposite case.

Oil Shock Impact Upon Energy Companies Investment Portfolios. Trends and Evolutions in the Energy Consumption Sector

“…Yang et al (2019) determine the correlation between stock markets and crude oil using a panel data analysis and conclude that the credit risk and economic activity have a negative effect while risk-free rate encounters' a positive effect. Between exchange rate movements and oil shock prices using a Markov switching model, there can be identified a high volatility unstable regime and a low volatility stable regime regarding the Korean case study (Kim et al 2019). Other authors are using different Markov switching models and reveal that with the Gaussian model there can be registered the best results in the oil market (De la Torre -Torres et al 2020).…”

Markov-Regime Switches in Oil Markets: The Fear Factor Dynamics

“…3 See for instance, Kim et al (2019), Wang and Xie (2012), Choi and Hammoudeh (2010), Mensi et al (2013), Raza et al (2016) and Creti et al (2013), inter alia.…”

Strategic alignment of pricing oil products from Brent conditionally on market regimes using Markov and cluster‐based switching dynamics

“…Regarding the relationship of oil with foreign exchange it is worth to mention the papers of Anjum and Malik (2019); Golub (1983); Jawadi et al (2016); Lizardo and Mollick (2010); Roubaud and Arouri (2018). For readers who need an extended literature review on the research of the relationship among oil and exchange rate Kim et al (2019) provide an extended taxonomy per country, period, method and results. Finally, as regards to the macroeconomic effects we can refer to the work of Kim et al (2019); and Mork (1989).…”

“…For readers who need an extended literature review on the research of the relationship among oil and exchange rate Kim et al (2019) provide an extended taxonomy per country, period, method and results. Finally, as regards to the macroeconomic effects we can refer to the work of Kim et al (2019); and Mork (1989). The impact of oil price on growth rate has been studied by Jiménez‐Rodríguez and Sánchez (2005), and on inflation by Bloomberg and Ethan (1995).…”